If you're Ray-Ban sunglasses, the average age of your wayfarer brand that has been a hot seller since 1962 probably doesn't matter. If you, in fact, manufactured them in 1962, it is likely you would have paid a lot less than it costs you today to manufacture the same glasses, but little else will have changed. And, in reality, most companies go through all of their inventory within their current year.
So while this structure doesn't matter as applied to sunglasses, which last forever, think about average age of inventory as regards an egg farm. An hour after Henny Penny has pooped out an egg, it begins a process of going bad. And after a week or two, it is probably fertilizer. So tracking that average as it applies to volatile inventory matters a lot.
But average age refers to another, potentially more important metric, which reflects how quickly a company's inventory is turning over.
So think about two extreme cases. Black & Decker hammers have become the darling of drug dealers and other mob money collectors. Supplies have been flying off the shelves, and the CFO of B&D notes in the quarterly conference call that the average age of his hammers in inventory has gone from 47 days to just 32 days. This metric may be a problem, in that the company has to produce more inventory to keep on hand, but for most companies, it's a good problem.
At the other end of the inventory spectrum, with the failure of most male enhancement drugs, sales of tape measures have flagged dramatically. Stanley Toolworks notes that the average age of their 24-foot stallion model has ballooned from 23 days to 34 days, and they probably have a problem.
The gist is that the age of inventory reflects sales volume as well as the efficiency of capital management, i.e. capital invested in a company's inventory, which is a bit like Goldilocks' porridge. Company managers seek that inventory to be not too hotly turned over, not iced, but rather living somewhere in the middle.
Related or Semi-related Video
Finance: What is Inventory Turnover?2 Views
Finance allah shmoop What is inventory turnover All right well
this is inventory and this is a turnover Okay so
what is it really Well you have inventory I'ii stuff
you want to sell and then you sell it You
started the year with a thousand edible necklaces The pumpkin
spice model promises to be very popular anyway You sold
them for ten dollars each So you have ten grand
in inventory But you did five hundred eighty thousand units
of sales inventory turnover Big Really big five hundred eighty
times big Okay different story Your tesla You have one
hundred tires in inventory You had that same number january
one in april twelfth In july twenty third and december
Thirty one of this year One hundred tires steady state
But you sold fifteen thousand cars in a year We'll
let four tires apiece Yeah That's a sixty thousand tires
And we're not counting that thing in the trunk It's
Not really a tyre anyway It's More like a bicycle
tire Enormous inventory turnover Sixty thousand over one hundred or
six hundred Ex enormous inventory turnover Very efficient use with
the capital spent on those hundred tires Well so why
Does inventory turnover even matter Alright Yeah it's about capital
We hinted you there Think about your capital needs Like
if you have to raise tons of money to store
tons of inventory that you take forever to sell Well
then you're not using your capital very efficiently Like why
not make the tire manufacturers who are actually in the
business of building distributing and planning for tyre demand Why
not make them hold all the inventory using their capital
not yours Well not all inventory turnover numbers mean the
same thing like what's inventory in an oil rig leasing
company Well you keep eight rigs on hand you know
you'll have to tow them out to the middle of
the ocean At some point they're crazy expensive to build
and maintain and some years when oil is really cheap
there just won't be any demand for your rigs for
drilling so you'll have to store him and oil them
and wave to them kindly So how do you make
sense out of that number like oil rig Turn over
when you're comparing it to say a grocery stores turnover
where the average six pack of diet coke last like
fifty three hours on the shelves made so inventory turnover
is really more of a quote relative to last year
unquote thing or a quote relative to our hated competitors
bob unquote kind of thing And there are ways to
game this data point as well the easiest of which
is well too Just let your inventory amount fall like
if you started the year with a thousand naked cupid
hood ornaments and let supplies dwindled to just two hundred
while then via industry norms of just taking the average
quarterly inventory levels through the year Well you might show
an average inventory of six hundred units this year thereabouts
and you'd be going into the next year with only
two hundred and generated a lot of cash along the
way Like you turned all that money that was tied
up in your inventory in the cash on your bottom
lines that good Is it bad Well just like pretty
much everything in from of finance videos and diapers it
depends Well it's good to have low inventory to a
point What happens if you run so low that customers
can't buy from you because you can't fill orders for
three months and then they go to bob than the
cost of not having enough inventory was massive You lost
sales profits and market share or power or theft and
it hurt your brand like people don't respect it as
much anymore Yeah sorry just keeping it real But in
general high turnover is good It means you're using your
inventory capital of the capital you spent to build your
inventory efficiently and that when you make it to the
top of the hill you're you know able to keep 00:03:43.925 --> [endTime] your balance Yeah
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